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Packing the Parachute

Success in the brokerage industry can be as much about mindset as anything else, so it comes as little surprise that advisors avoid negative thoughts, such as the potential necessity of a quick exit from their practice. At the same time, numerous factors are forcing reps to come to terms with the fact that their professional fortunes could turn on a dime, perhaps requiring a hasty sale of a practice.

Success in the brokerage industry can be as much about mindset as anything else, so it comes as little surprise that advisors avoid negative thoughts, such as the potential necessity of a quick exit from their practice.

At the same time, numerous factors are forcing reps to come to terms with the fact that their professional fortunes could turn on a dime, perhaps requiring a hasty sale of a practice.

But even those with stable situations have good reason to reassess their willingness or ability to remain in the brokerage industry. Here's a short list of factors that are making operating a brokerage operation more difficult:

Many brokers are finding it difficult to respond to the tremendous pressure on them to transition from transactional to a fee-based business.

Paycuts (which often are part and parcel to fee-based initiatives) have made it increasingly difficult for transactional brokers to make a living. Many firms have tilted grids to reward fee-based business. UBS, for example, has levied a $12 ticket charge on a broker's net commission on each transaction. As one broker said recently, “At a 30 percent payout, I'm not making any money.”

In the wake of the scandals, many brokers find re-establishing trust — with both clients and compliance folks — to be an uphill battle. Indeed, in the event of irregularities, brokers are treated as guilty until proven innocent in just about all practice-related disagreements.

The hypervigilant compliance environment is drowning brokers in paperwork.

Average Joe brokers have become persona non grata at most firms. Managers are focusing on recruiting high-producing teams, with clients who have in excess of $5 million in investable assets. Smaller clients and the advisors who serve them are no longer sought after or welcome by the firm's management.

Know Your Value

These trends make it imperative for brokers to understand the intrinsic value of their practices and what options they have for making a transition to the next stage of their lives.

Whether a broker is two years or 20 years into his practice, he must always have a plan in place to position his book of business so that it is sellable when it benefits him.

“You can't sell what you don't own, so if you work for a wirehouse or big firm as a W2 employee, you don't own your book and you are not permitted to sell it," notes David Grau, president of Business Transitions, a Portland, Ore.-based business broker specializing in assisting brokers in buying and selling their books.

This doesn't mean that wirehouse denizens should simply ignore the transition issues. Unless they have planned an exit strategy, the usual procedure upon a broker's departure is for the branch manager to distribute the book among brokers in the office. Even if the departing broker has a good relationship with those in his office, this rarely works out well for all involved, since branch managers tend to use the account distribution as a political tool, giving the best accounts to those owed favors, and so forth. Any advisor who has spent years caring for clients is likely to want them to be well cared for, and this can only be assured with careful partnership planning. If you establish a partnership within the firm, you can control what happens to your book.

A wirehouse broker who wants to profit more directly from his book can do so by going independent for a short time (garnering a transition package from a new broker/dealer in the process) and then later selling the book on the open market.

For independent brokers, of course, departing the business is a much more straightforward process, because their books can be appraised and sold on the open market. Grau says that most independent brokers sell their practices between ages 52 and 57. He notes that many of the sales decisions are triggered by a sudden or unplanned life event, such as an accident, divorce or disenchantment with the business.

Typically, brokers sell their books to younger advisors in close geographic proximity. Ideally the selling broker finds a like-minded professional who will manage the book in the best interests of the clients.

The Big Bump

When the selling broker puts his book on the open market, its value typically soars. For example, if the broker grosses $400,000 and gets a 90 percent payout from his b/d, the book is assigned a value of $360,000 (calculated as the trailing 12-months gross revenue generated, net of b/d override) with a 2.1 multiple. It would then be worth approximately $756,000.

A typical arrangement will pay the broker 30 percent cash as a down payment with the balance paid over the next three to four years. In this type of transaction, the buying broker usually realizes 95 percent to 98 percent retention of clients. These deals typically close in eight to 10 weeks from start to finish.

Some regional and wirehouse firms offer “sunset” plans, whereby retiring brokers receive progressively decreasing revenue from their books for three years, after the accounts are transferred. The broker must help transfer his book and assist the new broker in developing relationships with his clients. Some firms will offer a continuation of medical benefits during this period of time.

In the end, it's clear that planning an exit strategy can mean a significant difference in a broker's overall wealth at the time of career change or retirement, and that independents are best positioned to take full advantage of the bail-out opportunities.

A wirehouse broker, in the best of circumstances, gets no control over who gets his book or how the new broker will handle the clients. By contrast, the independent broker with an exit strategy in place receives greater compensation for his book and the knowledge that he has handpicked his successor.